This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the top of any article.

This Year's Bond Shortfall Seen Hitting $460 Billion

Mismatch between supply and demand boosts bond returns.

The supply of bonds worldwide will fall $460 billion short of demand this year, underpinning support that confounded forecasters and sent the fixed-income market to its best start to a year since 2003.

Debt issued by sovereign, corporate and other borrowers will decline by $600 billion to a net $1.8 trillion in 2014, as demand reaches $2.26 trillion, according to New York-based JPMorgan Chase & Co., the world’s biggest corporate bond underwriter. Demand has pushed down average bond yields to levels unseen since May 2013 as economies slow, borrowing is reduced and central banks signal no rush to start raising interest rates anytime soon.

The imbalance helps explain why most forecasters have gotten it wrong this year when predicting bond prices and yields. The market received a boost on June 5 when the European Central Bank became the first major central bank to charge fees on deposits and unveiled other plans to support an economy threatened by deflation.

“Everybody was expecting supply to come down, but maybe it’s coming down sooner” than anticipated, said Sean Simko, who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania. “There’s a shift in sentiment from the beginning of the year when everyone expected rates to move higher.”

In the U.S., increased buying from retail investors, commercial banks and foreign institutions in the first quarter helped pushed Treasury yields to the lowest levels in almost a year. Borrowing costs for the riskiest companies dropped to a record low last month and yields on bonds of once-troubled nations in Europe, such as Spain, have dropped to all-time lows.

“We’re going to be range-bound in a lower range than previously expected,” Simko said in reference to yields.

Globally, bonds have returned 3.7 percent this year through June 6, the biggest year-to-date gain since 2003, according to the Bank of America Merrill Lynch Global Broad Market Index. The index, which tracks almost 22,000 bonds with a face value of $43 trillion, fell 0.3 percent in 2013.

Yields on global bonds dropped to 1.76 percent on average last week, after reaching 1.7 percent on May 28, the lowest level since May 2013, according to the index.

Negative Rates

In developed countries, benchmark yields in 24 of 25 nations tracked by Bloomberg have declined this year, with those in Italy and Spain touching record lows.

ECB policy makers led by President Mario Draghi cut their deposit rate to minus 0.1 percent last week, lowered the key interest rate to a record 0.15 percent and announced measures including targeted loans known as longer-term refinancing operations. ECB staff also cut all inflation forecasts through the end of 2016, seeing consumer prices rising 0.7 percent this year, compared with an earlier prediction of 1 percent.

The moves followed a first quarter when the U.S. economy contracted 1 percent and tensions between Ukraine and Russia intensified. The Paris-based Organization for Economic Cooperation and Development cut its forecast for global growth, saying in its semi-annual report on May 6 that the world economy will expand 3.4 percent this year instead of the 3.6 percent predicted in November.

Global bond funds, which are 90 percent owned by retail investors, shifted to buying $80 billion per quarter in the first half of this year, after selling of $40 billion per quarter in the second half of 2013.

Retail investors “want to hedge their bets after an extraordinary year for equity markets in 2013,” Nikolaos Panigirtzoglou, the global market strategist in London for JPMorgan, one of the 22 primary dealers that trade directly with the Fed, wrote in an e-mail. “Instead of selling bond funds to buy even more equity funds they decided to invest their excess cash equally between the two asset classes this year.”

In October, JPMorgan forecast that the supply of bonds worldwide would exceed demand in 2014 by $280 billion.

U.S. commercial banks have bought $50 billion in bonds this year, compared with purchases of $27 billion in all of 2013, according to JPMorgan. Bond buying by foreign official institutions, including foreign exchange reserve managers and sovereign wealth funds is expected to climb to $600 billion in 2014, up from $400 billion last year that was the lowest since 2007, according to the bank.

Defying Predictions

U.S. pension funds and insurance companies together purchased $46 billion of bonds in the first quarter, just below the average quarterly pace of 2013, JPMorgan said. Their purchases helped to narrow the gap between the yields on U.S. 10-year notes and 30-year bonds, known as the yield curve, the bank said in the report.

The move in government bonds has defied predictions for higher borrowing costs, with 10-year Treasury yields falling to 2.61 percent yesterday from 3.05 percent in January. Forecasters now see yields on 10-year Treasuries rising to 3.25 percent by year-end, estimates compiled by Bloomberg show. At the start of the year, the forecast was 3.44 percent.

The surprise “is how significant it’s been and how long it’s lasted,” said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut, referring to the drop in yields. “Markets were too optimistic on growth.”

Treasury & Risk

Treasury & Risk is an online publication and robust website designed to meet the information needs of finance, treasury, and risk management professionals. Our editorial content, delivered through multiple interactive channels, mixes strategic insights from thought leaders with in-depth analysis of best practices, original research projects, and case studies with corporate innovators.